Economic Musings V: Subsidies, Brothers and Nannies

There are a thousand-and-one reasons why states “need” to subsidise economic activities. And there are at least as many critiques as to how the money was wisely spent, should not have been spent, should have been spent on something else, was too little, too much, at the wrong time, too early, too late, wasted or wonderful. Any policy that meets with such contradicting praise or censure is worth a deeper look.

Let’s imagine, a state wants to help the “X” industry for some reason or other. One reason is that without such help or seed money the industry would not come into existence or not develop fast enough, another that some other state unfairly pampers his “X” industry and therefore the state needs to finance “his” X industry just to restore a “level playing field”. Another might be that, admittedly, the industry is “on its way out” but to not lose jobs precipitately one needs to see to a smooth transition etc. As I said, there’s thousand-and-one reasons why states should subsidise economic activities.

And, tragically, taken each by itself, these arguments often make a convincing story. What is missing in the bigger picture is often the rest of the whole story, like how that affects the “Y” industry and the “Z” savers or taxpayers etc. But we run ahead of ourselves.

CrisisMaven thinks we should probably split up the argument into smaller chunks. One chunk we already covered yesterday, namely that any state spending the wherewithals of which need to be raised in the (capital) market place or through taxation has a contracting, not a multiplicative effect on overall wealth. Either it directly diminishes wealth which we could call squandering or outright waste or at least and irrefutably it diminishes wealth indirectly and relatively to leaving the money where it was invested (or would have been invested) in the first place. Whoever thinks that the state, and only he, can create positive wealth effects by first withdrawing money, by whichever means, from the economy only to give back a smaller portion than was extracted (due to losses in transmission), in short, he/she who believes in miracles of course may see only positive (“multiplier”) effects in subsidies. If so, they should read other blogs and literature, maybe after telling us, why then we stop short at any particular sum and do not expand subsidies indefinitely as they can only have positive effects in each and every case. If not in each and every case then we’re back to the quandary as to how to determine to spend how much when and where and why a bureaucrat knows better than the people that owned the money before he took it and diminished it by consuming a (not so) small amount.

So if we try to adhere to the school who see subsidies as, while to them still ultimately an indispensable policy tool, to be used with discretion and only under certain narrowly prescribed circumstances, and acknowledge they maybe diminishing wealth so must be “means tested” and should be limited in time, scope and area of application, in other words, if we go along with people who hire consultants to tell them what they want to hear, then we need to ask one and only one question:

Does a subsidy ever, at least sometimes, achieve a better result than abstention?

While in discussing the multiplier we discovered that such can never be positive and we were forced to draw the conclusion that states should leave such seed or stimulus money well alone as it could never outweigh the negative effect the withdrawal of the money later to be spent leaves on the economy, unless one resorted to inflation, i.e. introducing new, hitherto not existing money which then though could only nominally, but never in real terms, “stimulate” the economy.

With “well-founded” subsidies, however, the problem is not as clear cut. Even if an apologist of subsidies were to declare that he was aware of the negative, the contracting, “multiplier” effect he/she might point out, that even then certain areas of an economy need either help in retiring or in starting up or, short of a real war, a trade war needed to be won against a country that resorted to dumping etc.

In real war or in emergency rooms there are costs involved that are unproductive but need to be spent to avert an even greater loss. And any subsidy framed in this paradigm might still be immune against the accusation of, overall, contracting the economy. Regularly money e.g. allegedly needs to be pumped into energy research, starting the conversion of “the” economy towards a path of self-sustenance, of minimising the dependence on oil, that nuclear fusion needs first to be developed to a stage after which industry could then take over (profitably) etc.

There is a general fallacy at least in the last argument: if it were at all foreseeable that future returns repay more than the initial start-up capital needed, e.g. to get fusion going, then industry and the capital markets would actually long since have found a way to finance the effort. Even private space travel is now a fact and no one would have ever given that a chance, not over fusion certainly. The fascinating thing about private space travel? That it developed alongside and against a completely subsidised public competitor! If that’s not proof, then CrissMaven wouldn’t know what is.

So all these proponents of e.g. subsidising fusion are really saying is that “this kind of energy generation will forever be a lossmaking deal” – inasmuch as can today be foreseen and there’s no research entity run by the state that has more knowledge than private research institutions – and if one of them had, and it made its findings public in a convincing manner, immediately industry would again pick up from here rendering energy research subsidies obsolete.

So that kind of subsidy is just another way of saying that “we, as an administration, want to ride a hobby horse” (and as long as you, the taxpayer, still have money, we will continue to ride, feed and fatten it). That’s not sound policy, forgive me, that’s not even childish; foolish might be the right word, but then those people should be in an asylum.

So let us now look at another typical subsidy, e.g. for business start-ups, small and medium businesses, or at small research grants for research that a company actually saw some need for (other than fusion in the last example) and so on.

Let’s say there are two brothers, one a civil servant or a well-paid lawyer with money to save and to spare, the other a toolmaker who owns a small workshop and would need money to expand his business. Now nanny state can collect monies via taxation or by selling bonds, then set up a program whereby small toolmakers would profit if they hired at least one worker over and above their current workforce (let’s say brother toolmaker had five workers already, he’d then have six). For that, brother saver has to part with some of his money.

Subsidies always come with a “purpose” and are financed via taxation or by “saving” through buying bonds either directly from the state or from semi-state entities that brother saver believes to have at least an implicit government backing (as they all have as we’ve seen).

Had that money not been taken away but stayed in the economy it would surely have been re-invested somewhere else, without the transmission loss due to state collection operations. But we can ask ourselves: why has brother saver not given the money to his brother directly? Why has brother toolmaker not asked his brother directly (ok, not all brothers are on speaking terms, but there’s nothing to suggest that this might not have been more natural -and for millenia it was- than letting the money take a grand detour through state’s coffers)?

Well if brother saver was taxed he didn’t have that choice obviously. If he wasn’t taxed but father (or nanny) state raised the money for the subsidy via a bond issue, then, even if he theoretically had a choice, as a father with a family to keep up he equally had no real choice: treasuries were considered so much safer than self-employed brothers that he would have rather given the money to the state to in turn give to his brother. Now, hold on a minute: if you were from New York, your brother in New Jersey (or from London and your brother in Reading) would you rather give your money to a brother in New Jersey or Reading than to a complete stranger in, say, Minnesota or Edinburgh?

You probably would not give your money to any complete stranger, and certainly not, if you cared for your brother at all, as long as your brother wanted?! Why would you not give to a complete stranger? Because you would not feel very secure about such a deal. So, pray tell me, if you funnel that money through enlightened state agencies would repayment be any more secure than if you had given it to strangers? Probably not? Is the state’s guarantee then adding any value to the transaction? Some may say, yes, if the state doesn’t get repaid he’ll get the money to repay from somewhere else. It’s true, that’s “some” guarantee. But can you go on like this forever? Surely not. And since many subsidies have clauses where you need not repay if you “can’t”, unlike in the average private credit transaction, all we can learn from that set-up is:

There needs to be a damn good reason for any subsidy if it can beat lending between brothers and still then result in a greater net gain to society at large (not individuals – there’s always someone who profits net from a subsidy, though even that is often a two-edged sword) than if the supporter and the one in need had dealt directly.

And why has brother toolmaker also not asked brother saver directly (a likely scenario under normal circumstances)? Because he knew there was this subsidy program, tailored “exactly for him”, complete with consultants to help him through the paperwork at “no” cost etc. – but he never reflected and no one ever told him that the money was actually his brother’s (but only in part, the rest already having been lost on that long detour towards him). Now he knows …